FDIC seal

As is common in banking crises, the bank regulatory, congressional, and presidential/executive branch reaction to the failure of Silicon Valley Bank (SVB) represents risks to banks and their insiders.

This has happened before – a lot. For example, during the Savings & Loan (S&L) crisis and the Great Recession. Whenever a bank fails as spectacularly and as suddenly as SVB did, it is appropriate (and in certain cases, legally required) to conduct post-mortem reviews.

We’ll soon know what went wrong in detail – mistakes made by management, the board, outside auditors, advisors, and by the Fed and FDIC. The board and management will be vulnerable to both FDIC suits as receiver and to enforcement actions.

But what will be the impact on existing banks and their directors and officers?

We worry that the Congress and the agencies will learn wrong lessons from the facts and apply them to open banks. This has happened repeatedly. In the past, Congress reacted to banking crises by passing legislation creating new restrictions and granting the federal banking agencies more powers that were both unnecessary and burdensome, causing harm to the banking industry without commensurate benefit.

It didn’t seem to matter that the federal banking agencies already had enormous power to take enforcement action against banks and their insiders. They really didn’t need more authority, but they got it anyway.

This may be already happening. President Biden has proposed onerous legislation. Senator Elizabeth Warren (D-MA) and co-sponsors have introduced a bill that will claw back compensation of bank officers going back five years if their bank fails, regardless of whether they were at fault. The agencies already have cease-and-desist powers to claw back compensation if the individual director or officer was at fault.

In the past, federal banking agencies have reacted to crises and challenges by overusing their broad enforcement powers. They conducted overwrought examinations leading to overwrought, unnecessary, and burdensome enforcement actions and to personal liability imposed on insiders.

A Deloitte report shows that between 2009 and 2015 (during and immediately after the effects of the Great Recession) the federal banking agencies imposed 8,631 formal enforcement actions. The number of informal actions such as Memoranda of Understanding (MOUs) and letters of reprimand was perhaps even more numerous but incalculable because many are not disclosed.

Many of these enforcement actions were likely to have been unnecessary. For the most part, bank boards and management follow the direction and recommendations of the banking agencies without the need for formal or informal enforcement action.

We will again witness examples of the abuse of power by the banking agencies. They have virtually unbridled authority to remove directors and officers, fine them, and ban them from banking. Directors and officers of failed banks face the very real prospect of the FDIC suing them for damages.

Our recent Supreme Court filing to support the due process rights of a bank chairman and CEO facing supervisory removal based on purported examination abuses is a fresh reminder that the banking agency use of their enormous power must be tempered by a need to use those powers judiciously.

At times like this, the pressure on the agencies to take action – any action – is enormous. They know if they err in not acting, they will be criticized, but if they err in acting, no consequences for them will follow. The pressure will come from members of Congress and congressional committees, the executive branch, the media, and the public. It is times like these when the due process rights of banks and their directors and officers can be trampled upon.  Bank boards of directors need to be prepared for these developments by being anticipatory in their strategies. Upcoming AABD alerts will address these challenges and what to do about them with more detail.